Sunday, September 7, 2008

Fannie Mae, Freddie Mac Roundup II: Saturday (FNM; FRE)

We'll have a post or two when details of the bailout come out this afternoon. In the meantime here, in no particular order, is some of the more interesting thinking from Saturday.

From theStreet.com:Cramer: Fannie, Freddie Takeover Changes the Game

Right now, at this moment, many people know that something good is going to come from this government takeover of Fannie(FNM) and Freddie(FRE), but they don't know how it relates to the market.

So, let me tell you how I see things unfolding. We know that our economy started rolling over because so much money -- trillions -- has been bet on house-price appreciation.

The wagering on American house-price appreciation has taken place in every venue and, in many cases, with gigantic leverage, magnifying a problem of historic proportions with a financial Armageddon quality we have not seen EVEN IN THE GREAT DEPRESSION. In other words, not since the Great Depression, but including the Great Depression. That's how important it was for houses to appreciate.

We are now in a double-digit decline of housing that has made most houses bought since 2005 worth less than their mortgages. House-price depreciation has been so relentless, particularly in Florida and California, believe it or not, two states that could bring the whole financial edifice down, that if it isn't stemmed then it's difficult to stop a severe recession, if not depression, given the abrupt slowdown of the rest of the world and our own skyrocketing unemployment.

The only hope to break the chain of despair and turn around the endless declines in home values to the point where you SHOULD walk away from a home with a mortgage larger than the value of your house, is to stop this house-price depreciation.

So far we have failed so badly in doing so that borrowers of even the highest quality are now defaulting. That's wrecking the bonds and derivatives and the insurers of the bonds and derivatives and anyone that is holding mortgage paper.

The Treasury's takeover of Fannie and Freddie can change that because once mortgage paper packaged by the government enterprises is federal government paper, then ANYTHING can be worked out with the borrowers, and the borrowers represent the lions' share of the troubled homeowners in the country who have not already defaulted....MORE

The New York Times, in "Loan Giant Overstated Its Capital Base," sets forth an interesting bill of particulars as to where Freddie deviated from what one might consider a full and fair statement of its financial condition. Indeed, the article says that the widely-expected Sunday intervention was triggered by the GSE's regulator determining that the firms' capital was short of the reported level (note that Fannie's practices were not as aggressive as Freddie's). Bloomberg had indicated yesterday that the rescue was being announced prior to a FHFA [Federal Housing Finance Agency] evaluation of their capital. We noted:

... it seems likely that there was something due to be released [in the report] that either gave James Lockhart, the head of FHFA, the smoking gun to intervene, or was sufficiently troubling to run the risk of an adverse market reaction...

Yet, as Calculated Risk pointed out, the Times had an artfully worded comment (emphasis ours)

The company had made decisions that, while not necessarily in violation of accounting rules, had the effect of overstating the companies’ capital resources and financial stability.

From the Ludwig Von Mises Institute (Aug. 22):The Real Cost of a Full Bailout

A recent study from the Congressional Budget Office (CBO) has zero credibility. It pegged likely taxpayer losses in the Fannie Mae and Freddie Mac bailouts at $25 billion. For those with a sense of history, it is worth remembering that the S&L bailout had a $160 billion price tag. The numbers diverge so far from reality as to be laugh-out-loud funny. Funny, that is, except that the CBO estimate demonstrates a willful disconnect with the actual consequences of federal government actions.

As demonstrated below, the real cost of the bailouts will easily exceed $1.3 trillion. In fact, the real cost is likely to range between $1.3 trillion to $1.6 trillion, and is not unlikely to reach $2.5 trillion....MORE

...These two gigantic hedge funds intentionally manipulated their accounting to show a capital position that was stronger than reality, by pushing forward losses instead of recognizing them as they occurred.

While not illegal, it had the effect of lying to the markets, which put both firms at risk of all-on collapse.

Now the government proposes to bail them out at your expense and risk the collapse of the government's funding, instead of indicting the executives of these firms and placing them into rundown, forcing the losses to be taken by the people who profited from the gains during the "salad years."

And once again, I reproduce the specific language on the front of a July 2008 Fannie Mae "passthrough" debt certificate:

I didn't make this up folks. It is on the face of every single debt prospectus issued since these firms were public companies - thirty years worth of time.

In other wordsevery single holder of current debt issued by these firms has this on the face of their prospectus. Every single one. All of the GSE debt outstanding is 30 years or less in duration; ergo, every single person who has ever purchased any of this debt is well-aware of the risk involved in doing so.